Corporate Taxes, Strategic Default, and the Cost of Debt
44 Pages Posted: 7 Nov 2012 Last revised: 27 May 2013
Date Written: November 7, 2012
Abstract
The current U.S. tax code’s loss carry provisions provide implicit tax subsidies to financially troubled firms. Since shareholders ultimately decide when to announce bankruptcy, such tax subsidies can incentivize them to strategically postpone default. Therefore, corporate taxation can influence corporate cost of debt. Using a large panel of corporate bonds, we find supporting evidence: credit spreads become smaller as tax loss carries grow larger. In contrast, tax shields such as depreciation, which limit loss carry gains, lead to wider spreads. Interestingly, when stockholders hold greater bargaining power ― due to large managerial ownership ― larger corporate tax shields lead to even narrower credit spreads.
Keywords: Corporate tax, Credit spreads, Endogenous bankruptcy, Strategic default
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation
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